Public Bill Committee

[Mr. Jim Hood in the Chair]

(Except clauses 3, 5, 6, 15, 21, 49, 90 and 117 and new clauses amending section 74 of the Finance Act 2003)

Jane Kennedy: On a point of order, Mr. Hood. It is a pleasure to be here this morning on the last day before the Whitsun recess. Speaking for myself, I need a haircut and a holiday, although not necessarily in that order. My compliments to you, Mr. Hood, for stealing the hands of time and correcting the clock. It will help us to a great extent.
I wish to update the Committee. I undertook to publish amendments relating to residents and non-domiciles for a future debate. I said that they would be laid as soon as they were available and that full explanatory notes would be provided for each one. To provide the maximum opportunity for scrutiny before the debate, I propose to table each amendment formally when it has been prepared rather than release all the amendments at the same time. They will then be published on Her Majesty’s Revenue and Customs website to ensure that the widest possible audience can be informed of their contents before they are discussed in Committee. If the amendments are ready for release during the Whitsun recess, I shall place them on HMRC website in draft, having circulated them to the Committee, and then table them during the week commencing 2 June when the House returns from the recess. I anticipate that that will happen with the first such amendment, which is to paragraphs 37 and 38 of schedule 7.

Jimmy Hood: That was not a point of order for the Chair. However, the Committee will be grateful to the Minister for the information.

Clause 50

Gift aid: payments to charities

Question proposed, That the clause stand part of the Bill.

Philip Hammond: I have a couple of points to make about the clause, but I wonder whether it would be more appropriate to make them when we speak to schedule 19, which contains the substance of the matters raised by the clause. I shall be happy to do so.

Question put and agreed to.

Clause 50 ordered to stand part of the Bill.

Schedule 19

Reduction of basic rate of income tax: transitional relief for gift aid charities

Question proposed, That this schedule be the Nineteenth schedule to the Bill.

Philip Hammond: The schedule introduces a provision for HMRC to make payments to charities in respect of donations that they receive that are subject to the gift aid scheme. It is to be called the gift aid supplement. The measure is intended to address the consequences of the reduction in the basic rate of income tax from 22p to 20p. An essential part of the symmetry of the arrangements of reliefs and allowances against income tax is that, when the income tax rate goes down, the value of the relief goes down. For my part, I certainly regard it as an important principle that tax reliefs are given against income tax, so when the rate reduces, the value of the relief will reduce.
Increasingly, however, we are debating the effect of reliefs, such as the impact on pension savings when the value of the tax relief is reduced. I am sure that other hon. Members who have a pension provision that they fund themselves will have had the same experience as me, and have received a letter from their pension provider telling them that because the income tax rate has gone down, their contribution will have to increase to maintain the benefit level.
Although the difficulties for charities were identified when the reduction in the basic rate of income tax was announced in the 2007 Budget, they are particularly vulnerable to the loss of income arising from the reduction. When that reduction was announced, it was also announced that there would be a thorough review of the take-up of gift aid. The implication—what was probably in the mind of the Government at that time—was a recognition that charities would face a loss of income. In a rational world, income tax-paying donors would give a little more, because they were being taxed a little less, and thus would compensate for the loss of the gift aid tax relief. In the real world, however, people do not make those fine-tuned adjustments. Certainly, when people are under pressure financially in other areas they are unlikely to make that adjustment. The thorough review of take-up was perhaps seen as a way of squaring the circle. If more effective use could be made of the gift aid scheme so that more of the money donated to charities was channelled through it, perhaps there was a way to increase the amount of income on which gift aid relief was claimed and thus compensate charities for the cut in the basic rate of income tax.
A consultation paper was published last summer and the view of the charitable sector is that there was not a great deal of meat in it. The sector responded by making various proposals, some of which were quite radical, about how the gift aid scheme might operate. None of those proposals, unless the Minister tells us differently today, has been taken up by the Government, who have no stated intention of doing so. The proposals included, for example, introducing some form of automatic refund gift aid contributions using an averaging process.
The announcement in the 2008 Budget of the measures in schedule 19 reflects the failure of the process that was kicked off in the 2007 Budget, to try to find another way of compensating charities by improving the uptake of gift aid. It would be useful if the Financial Secretary made it clear to the Committee whether it is still the Government’s objective in the long term to improve the take-up of gift aid in charitable giving, and whether what we have before us is, in fact, the Government’s medium-term solution. The schedule introduces a transitional relief, whereby charities will be compensated directly from HMRC for the reduced gift aid rebate and thus they will be kept whole, as it were, for a period of three years. That prompts the question, what happens after three years? Is that relief simply intended as a stop-gap measure? One or two cynics have remarked that three years gets us safely to the other side of the next general election. Is the period of three years related in a logical and explainable way to a longer-term strategy to address the underlying problem that has been created? Members of the Committee probably all agree that the best way to do that is to increase the take-up of gift aid so that charities no longer have to rely on the supplementary rebate that compensates for the missing income. Some indication from the Minister on the long-term thinking would be greatly appreciated.
The proposal in the Bill was welcomed by the charitable sector. If you were told, Mr. Hood, that you would be deprived of X per cent. of your income, you might worry about it for a year, but if you were then told that somebody would give it back to you for three years, your initial reaction would be one of gratitude. Perhaps only after two years would you start to think about what would happen after the three years. To some extent, this announcement has taken the pressure off the search for a longer-term solution to improve the take-up of gift aid or find another way of mending the hole in the fundraising of charitable organisations. We should try collectively to ensure that we do not allow this measure to distract attention from the underlying issue.
I have a specific but important question on schedule 19. Paragraph 1(5) will introduce condition D. There are four conditions on the receipt of gift aid supplement. Condition D is that the claim by the charity is allowed, which strikes the Opposition and most people in the charitable sector as rather an odd condition. It implies a degree of discretion by HMRC on whether to allow a claim by a charity. It is not a usual provision for an entitlement written into law that the claim to the entitlement is to be “allowed”, as if by some discretionary process.
I have not tabled an amendment to delete condition D because I would like to hear from the Minister how it is to be interpreted. Perhaps there is a technical reason for its inclusion, and the Minister can put on the record an assurance that properly made claims for gift aid supplement by charities will automatically be allowed, and that this is a mere piece of bureaucratic gobbledegook, not a real test implying that charities have to satisfy some additional conditionality that HMRC may introduce at an official level. That is the key issue that I wish to raise with regard to the schedule. If the Minister addresses it and the more general question about the medium-term solution, I should be very grateful.

Nick Palmer: I welcome the comments we have just heard, which were sensible and helpful. Going slightly wider, it seems that there is no overall rationale for how we work tax relief for charities. In effect, we say that if a person is taxed at the standard rate we will refund the tax to the charity, but if they are taxed at the higher rate, we will refund it to the individual. That is something that we have got used to, and it is not an unreasonable position in principle. However, as the hon. Member for Runnymede and Weybridge said, that system leads to uncertainty when the standard rate moves down or up. I wonder if, in the longer term, we should look at decoupling this and having a standard deduction that does not necessarily alter as the standard rate moves up and down.

Philip Hammond: Does the hon. Gentleman not accept that that would lead to the decoupling of the concept that charitable giving is something that an individual can do out of their gross income As I made clear, I attach a lot of importance to the idea that certain things, such as charitable giving and pension contributions, can be done by an individual from their gross income, before the tax man has his share.

Nick Palmer: That is an interesting point, but there is an essential difference between pension contributions and charitable ones. Pension contributions are, in effect, deferred income. If we, as individuals, have more immediately available income because tax rates go down, it is a rational and individual choice as to how much of that we choose to put into our pension funds. Whether we do, or do not, we are profiting directly. Charitable contributions are slightly different. Topping up our charitable contributions requires a separate decision. If we do not, do so the default position is that we profit but the charity loses. In the case of pension funds, we profit either way.
Basically, I welcome the principle that we need to consider the issues more widely. I am sure that the Financial Secretary will respond more fully to the specific point made by the hon. Gentleman, but HMRC has to protect itself against the possibility that the charity is unknowingly submitting a claim that is not valid—for instance, because the person who made a contribution to the charity is not a standard rate taxpayer.

Jane Kennedy: This has been a helpful, brief discussion. All the proposals made during the consultation were considered and discussed across government. I met a number of organisations that made representations. The proposals are complex, requiring a full assessment of any risks to the current system and the funds that flow to charities through it. We are continuing to develop our thinking on gift aid, but at present our priority is to protect the status of this popular tax relief, rather than risk losing the benefits of the system.
We carried out a full and open consultation. As one might expect in such a broad area, views vary widely across the charitable sector. We responded to issues on which there was consensus: transitional relief, the provision of better guidance—and there has been a lot of effort from HMRC to offer a simpler approach, and tools to help charities drive up gift aid. In response to my hon. Friend the Member for Broxtowe, the consultation showed that opinions on higher-rate gift aid varied widely, with some people believing that the relief should go directly to the charity, and some people believing that basic rate relief should also go to donors. There was a wide divergence of opinions.
The transitional period is a three-year breathing space to allow charities to adjust to the change in the basic rate tax without it affecting their existing expenditure plans. During that period, charities can drive up more gift aid income with support from the rest of the gift aid package announced in the Budget. In addition, we will work with donors and charities to develop an understanding of donor behaviour, using that to inform further thinking about gift aid—again, in order to continue driving up the take-up.
The hon. Member for Runnymede and Weybridge asked specifically about condition D, and posed a fair question. The transitional relief will be due to a charity where only the underlying donation and claim meet the requirement of the gift aid scheme—it is an application. Condition D in paragraph 1 ensures that transitional relief will not be payable when the underlying claim is invalid. A claim for gift aid may be invalid for a number of reasons—for example, the claim form may not contain the required information. HMRC cannot be expected to pay the aid in those circumstances and it would be unsustainable to make transitional relief payable, but not the underlying gift aid, in such circumstances
Without the provision, if donor behaviour remained as it is today, it has been estimated that losses for charities would be significant across the whole sector, running to more than £100 million next year. The amount received by charities from the supplement will be proportionate to their eligible gift aid claims. For every £1 of gift aid that is donated, charities will receive 3.2p in supplements, so the charities will continue to receive 28.2p in total for every £1 donated under gift aid.
The proposals in the Budget were widely welcomed by the sector. I acknowledge that, for some, there was a feeling of relief that they could have certainty going forward. There is continuing dialogue with the sector, which was as keen as we were to maintain the nature of gift aid. That formed the basis of much our discussions, and I am sure that there will be a continuing dialogue in the area.

Philip Hammond: I shall respond to the Minister’s specific comments on paragraph 1(5). I understand the thinking behind it, but I ask her to consider the language. If she is seeking to say, in that provision, that the underlying claim must be valid, that is already taken care of, because condition A in paragraph 1(2) is that a
“gift aid donation is made”.
According to the definitions in paragraph 7, a gift aid donation means
“a gift which is a qualifying donation”.
If she is telling us that the gift aid claim has to be properly made, we understand that as well.
However, the word “allowed” implies a degree of discretion. The Minister, perhaps unintentionally, has not confirmed for the record that a valid claim is automatically allowed and that there is no discretion.

Jane Kennedy: I accept the hon. Gentleman’s point. If a claim is properly made by a charity within the law and within the terms of the gift aid scheme, the claim will be allowed. When a claim is allowed, the supplement will automatically be allowed.

Philip Hammond: I think that the Minister has given the Committee the necessary reassurance.

Question put and agreed to.

Schedule 19 ordered to stand part of the Bill.

Clause 51

Community investment tax relief

Question proposed, That the clause stand part of the Bill.

Philip Hammond: I have a brief question on clause 51. It appears from the wording that the clause seeks to close an unintended loophole against devious mischief that the Government, the Treasury or HMRC have spotted. Would the Exchequer Secretary explain to the Committee what has given rise to the clause? What mischief has occurred that requires the provision to be introduced and, unusually, to be treated as if it has always had effect?

Angela Eagle: I am happy to explain to the matter to the Committee. I would call it an unintended kink, rather than mischief. I do not think that there is any blame intended or that underhand behaviour has gone on that has led to the clause. My brief refers to a “minor deficiency”, but I think that quite a good way of putting it is that there is an unintended kink in the community investment tax relief scheme legislation that could prevent a bank from obtaining tax relief under the scheme if it invested money with one of its own customers. The Committee may not be aware that the scheme is intended to encourage companies and individuals to invest in community development finance institutions, which provide finance to enterprises in economically disadvantaged communities, helping to reduce economic disparities throughout the UK.
The tax relief is generous. It is worth up to 25 per cent. of the investment spread over five years, so it is right that the rules restrict relief to cases in which there is genuine investment of new money in the community development finance institution. There is no relief if the investment is returned to the investor, for obvious reasons, or if it is funded from money that originally came from the community development finance institution.
An obvious funding source for a community development finance institution is its own bank, and the most obvious home for any funds raised by such an institution for the period between raising the funds and investing them in the enterprises that it wishes to finance is the same bank. However, under the current rules, bank deposits made by a community development finance institution in the course of its ordinary banking transactions may reduce or eliminate the value of any relief available to the bank in respect of investments made under the scheme. That is the kink. It is not an intended result, because it means that to secure funding from its bank under the community investment tax relief scheme, a community development finance institution must in effect sever its existing business relationship with its bank and re-establish that business elsewhere. That was not intended when the scheme was put together, nor is it sensible. The change, which is entirely beneficial to community development finance institutions and banks, will have a retrospective effect, because an unintended wrinkle in the structures has created an anomaly.

Philip Hammond: I thank the Exchequer Secretary for her lucid explanation. I am sorry if I detected mischief and underhand behaviour where there is none. I am glad that she does not see mischief and underhand behaviour in every kink in the arrangements. I have some experience of dealing with predecessors of hers who often were more inclined to see mischief and underhand behaviour wherever kinks occurred in the tax code. Was the introduction of the clause prompted by an instance of relief being denied to an institution, or has the issue merely been flagged up and is being pre-emptively resolved?

Angela Eagle: CITR was introduced in 2002. We examined how it had worked and talked to, and liaised with, the stakeholders in the sector—both those who wished to lend and the institutions that had developed to take advantage of the tax exemption. The issue came up in that discussion. We realised that the points that were made had merit, which is why the clause has been included in this year’s Finance Bill. I hope that, with that explanation, the Committee is happy to let clause 51 stand part of the Bill.

Question put and agreed to.

Clause 51 ordered to stand part of the Bill.

Clause 52 ordered to stand part of the Bill.

Schedule 20

Leases of plant or machinery

Jane Kennedy: I beg to move amendment No. 126, in schedule 20, page 264, line 36, leave out paragraph (a).
The amendment omits unnecessary words in paragraph 6 of the schedule. It is straightforward and technical, but I am happy to answer any questions about it.

Amendment agreed to.

Schedule 20, as amended, agreed to.

Clause 53

Sale of lessor companies etc

Question proposed, That the clause stand part of the Bill.

David Gauke: Thank you, Mr. Hood. It is a pleasure to serve under your chairmanship once again.
Clause 53 ensures that anti-avoidance legislation applies fairly where a partnership carrying on the business of leasing plant or machinery transfers that business to a single company. As such, we welcome it. It corrects schedule 10 of the Finance Act 2006, which addressed a concern about how leasing arrangements could be used as a tax-avoidance mechanism, incurring losses in the early years and then transferring them so that there was a permanent deferral of tax. The mechanism ensured that sellers would face a charge, with relief being provided to the purchasers of the leasing company. That worked well in a partnership-to-partnership arrangement but, due to various technical reasons and definitions, it did not work for a partnership-to- single company arrangement, as there would be a charge to the departing partners but it would not deliver relief to the successor company.
During a debate on the Finance Bill two years ago, a concern about the internal restructuring of partnerships was raised in relation to paragraph 23 of schedule 10. Whereas paragraph 13 of schedule 10 of the Finance Act 2006 contained an exemption from the regime for a group of companies, there was no equivalent provision regarding a group of partnerships. With a further two years’ experience following the 2006 Act, and given that wrinkle regarding partnerships, will the Minister say whether any concerns have arisen on that issue and whether any group of partnerships involved in an internal restructuring has been caught, perhaps inadvertently, within the regime although that was not the original intention? Subject to that query, we have no other concerns about the clause.

Jane Kennedy: It was acknowledged in the pre-Budget report that the schedule was having a detrimental effect on some transactions where there is no risk of a tax loss. It is difficult to deal with such transactions without opening up new opportunities for tax loss, and any action that we take must be taken in close consultation with the industry. We intend to do that, and we are looking closely at the problem.
The hon. Member for South-West Hertfordshire asked some thoughtful questions. The legislation in schedule 10 dealing with partnerships is complex because the partnership structures used by companies are complex, and the schedule had to deal with those complexities. Where a business is carried on by companies in partnership, the charge and relief are allocated to the partner in proportion to their shares in the partnership profits. That gives the right result as long as the business continues to be carried on by a partnership, but not where a business is transferred from a partnership to a single company. In that situation, the selling partners are charged for tax, but there is no mechanism for delivering relief to the successor company because it is not a partner.
More generally, clause 53 makes minor amendments to the anti-avoidance provisions introduced by schedule 10 of the 2006 Act. A minor defect means that the schedule does not work fairly when the whole trade is transferred by a partnership to a single company. The clause will ensure that schedule 10 operates fairly, even in that unusual situation. Furthermore, to ensure that no one can have been adversely affected, the changes introduced by the clause will be deemed always to have had effect. That degree of retrospectivity has been warmly welcomed.

Question put and agreed to.

Clause 53 ordered to stand part of the Bill.

Clause 54

Double taxation relief

David Gauke: I beg to move amendment No. 133, in clause 54, page 27, leave out lines 14 to 16 and insert—
‘(a) a transaction or arrangement entered into on or after 12th March 2008, or
(b) an asset acquired on or after 12th March 2008,but does not relate to an asset acquired on or after that date pursuant to a pre-commencement contract (see subsection (5)).
(5) For the purposes of subsection (4) a contract is a “pre-commencement contract” if—
(a) the contract is a contract in writing made before 12th March 2008;
(b) no terms remain to be agreed on or after that date;
(c) under the terms of the contract the acquisition of the asset on or after that date had already become obligatory on that date; and
(d) the contract is not varied in a significant way on or after that date.’.
I share the desire to get through some of the clauses as quickly as possible, but I am grateful that we can turn to amendment No. 133. With your permission, Mr. Hood, I will take this opportunity also to make one or two remarks about clause 54 in general, as that would, from my perspective, avoid the need for a full stand part debate.
The objective of clause 54 is to ensure that credit for any foreign tax paid on trade or professional earnings is no more than the UK income tax due on the same earnings. That is not an unreasonable objective, but we query the element of retrospectivity. However, I do not want to overstate that, and we will debate retrospective legislation at greater length when we discuss clause 55, which deals with a much more serious issue. The element of retrospectivity as regards clause 54 relates to the fact that subsection (4) applies to the
“payment of foreign tax on or after 6 April 2008, or...income received on or after that date in respect of which foreign tax has been deducted at source.”
That is retrospective in nature. An individual might have invested in long-term, income-generating assets, such as overseas properties, on the basis of the existing tax position but then find that they fall within the new regime very quickly—after 6 April 2008—and therefore get a different tax treatment than that which they anticipated when they made the investment. Amendment No. 133 proposes that we should instead consider the date on which the relevant transaction was entered into. If it was made after 12 March 2008, it should fall under the regime set out in clause 54, but if not, the person should continue to benefit from the existing provisions.
The amendment was tabled, in a slightly probing manner, for two reasons. First, and most importantly, there is a danger of creating a parallel system with two different tax regimes, the application of which would depend upon when the transaction was entered into, and that would create unwelcome complexity. Secondly, the Government argue that the changes confirm the existing practice but set aside doubts that have been expressed about how foreign tax credit is calculated following recent case law. I will take the words in the explanatory notes at face value, but perhaps the Minister could elaborate on the existing case law so that we can assess the level of those doubts, which can sometimes be more substantial than the Government are prepared to concede. I should like to test their position on that. We should tread carefully where there is an element of retrospectivity in legislation, and the onus is on the Government to justify the provisions that they have made.
The objective of the clause is to ensure that relief for foreign tax is given once and once only. There can be circumstances where the equivalent does not apply. For example, a UK investor in an overseas asset such as a US limited liability company might find that he was liable to tax overseas but would not benefit from any kind of relief. The Institute of Chartered Accountants has raised that point with the Treasury, giving the example of a UK business that has an interest in a US LLC. Under current law, no relief is available in the UK for tax paid in the US unless the LLC’s income is distributed, notwithstanding that the UK shareholder of the LLC will be subject to US tax on the LLC’s income as it arises—in other words, irrespective of whether it is distributed. Has the Minister considered that?

Jimmy Hood: Order. Before I call the Minister to respond, I should point out that it would be convenient to have the stand part debate at the same time as the debate on the amendment.

Jane Kennedy: The ICA wrote to us with several detailed requests for changes, but I do not want to be drawn into those as they are outside the scope of the clause. However, I would be happy to write to the hon. Gentleman with details of the consideration that is being given to those proposals and circulate that correspondence to members of the Committee.
The clause does not affect the entitlement to credit for any foreign tax paid before 6 April 2008, so it does not have the retrospective effect that the hon. Gentleman fears. It re-establishes a rule for foreign tax credit that has always been the accepted method prior to recent case law. I shall explain that in more detail in a moment. This is the internationally accepted method for calculating credit relief, and there has never been any basis for believing that the UK Government should allow unrestricted foreign tax credit. In that context, there is no justification for a change that would add substantial complexity and uncertainty to the rule. That is what the amendment would do, although I appreciate that it was tabled in a slightly probing fashion.
The Government have done nothing to encourage people to plan on the assumption that high rates of foreign tax will be subsidised by the Exchequer. We have always made it clear that the purpose of foreign tax credit is to eliminate double taxation and not to go any further than that. The clause merely restores that long-established view of how the law on tax credits applies. The case that has been mentioned involved Legal and General; it was a corporation tax case heard in 2006. The corporation tax position was restored by legislation in 2005, and the clause makes a parallel change for income tax. There is no justification for delaying the implementation of the clause, as the amendment proposes. That would introduce considerable complexity and uncertainty whereby different rules would apply to different foreign tax payments. The amendment would mean that for assets or contracts that fell outside the scope of the clause, foreign tax credit would be unrestricted, putting at risk tax due from wholly UK-based activities.
I will give some background to the clause, since we will have, as you have indicated, Mr. Hood, the main debate now. The effect of the clause is to restore the way of calculating foreign tax credit that was generally accepted before the recent case law. The rule that the clause re-establishes is endorsed by the OECD and overwhelmingly used by those countries that give foreign tax credit against foreign earnings. The clause amends how the maximum credit for foreign tax is calculated, when the foreign tax is paid on trade or professional income of an individual. The purpose of the clause is to ensure that the credit that we give for foreign tax is sufficient to eliminate double taxation, which is a risk. It does not go any further.
In particular, the clause prevents foreign tax credit being set against income tax due on UK earnings. For example, if a musician earns income from a performance abroad, he or she is likely to have to pay foreign tax on those earnings. The foreign tax can be set against the UK tax due in respect of the same earnings—those attributable to the foreign performance—but should not be set against income tax due on earnings from performances in the UK during the same tax year. The clause enables the year’s income to be subdivided, so that each activity that gives rise to foreign income is ring-fenced from other activity for the purpose of calculating credit due for foreign tax paid. The clause also ensures a result that is fair to the taxpayer, while placing a necessary constraint on credit for foreign tax to prevent it from spilling over into other activity, including wholly UK-based parts of the trade.
The amendment would require separate identification of the foreign tax paid by an individual in respect of contracts, arrangements, assets and so on, entered into or acquired before 12 March—Budget day—this year. That foreign tax would be given as a credit against income tax no matter how much or how little UK tax arose out of the contract or asset. That would mean that foreign tax would reduce UK tax on other earnings unrelated to the foreign tax payment, including wholly UK-based activity.
The amendment adds complexity and is unjustified. I appreciate that it was moved in a probing and questioning way. Nobody should expect the Exchequer to subsidise rates of foreign tax that exceed its own, or to allow foreign tax to reduce income tax arising on UK earnings. That is a reasonable position, and I hope that the hon. Member for South-West Hertfordshire will accept it and withdraw the amendment. If he does not, we will have to resist.

David Gauke: With respect to the Financial Secretary, there is an element of retrospectivity here, in that transactions entered into under one arrangement will be treated differently now, under the provision. That is not the clearest or most obvious example of retrospectivity—we will come to one in a moment. None the less, I recognise her argument. She referred to the Legal and General case of 2006, which she said had been dealt with as far as corporation tax was concerned in 2005. It appears that the Treasury was at least prescient in 2005. I imagine that those were various stages of the action.

Jane Kennedy: It was exactly that. Clearly, Her Majesty’s Revenue and Customs was aware of that, and the dispute arose some time before. The law was fixed, and would have always been so, because it was never intended to work as was implied.

David Gauke: I am grateful for that. It raises a concern that we will come back to in a moment.

Philip Hammond: Will my hon. Friend reflect on what the Financial Secretary has just said? As I understand it, she said that a court case was in progress with Legal and General, a pretty powerful organisation. HMRC obviously realised that the law was defective because in 2005 the Government amended the law to close the defect. If I understand her correctly, the Government allowed the case to be pursued through the courts at public expense, only to be defeated in a way in which they knew they would be defeated. If they did not know that, they would not have changed the law in 2005. Does my hon. Friend agree that that is a perverse course of action for the Government to have followed?

David Gauke: I think two points have been raised. First, my hon. Friend has raised the point about the interrelationship between specific cases in case law and statutes. We will return to that point in a moment. The Committee may want to reflect on the Padmore case of 1987, which provoked a change in the law. At least that change in statute was without prejudice to judicial decisions being made in the matter before the change in law was announced. It seems a rather strange position to change the statute in the middle of a case. It goes against certain aspects of the rule of law.
Another point worth noting, which we will also come back to, is that it appears that this matter was on the radar of HMRC and the Treasury in 2005. Given the way in which these cases tend to work over several years, it was probably on their radar in 2004, if not earlier. If that is the case, why are we bringing in this legislation that has an element of retrospectivity in 2008?

Mark Field: Does this exchange of views not sum up the concerns that my hon. Friend has put forward about retrospection? If a statute is changed halfway through a case, one can understand it if it is aimed to overcome loopholes in future. In such an instance, it is all the more important that there is no sense of retroactive intent for the very reasons that my hon. Friend has set out.

David Gauke: There are concerns about retrospective legislation. I do not take an absolutist line on the issue, but to minimise those concerns it is at least reasonable to expect the Treasury to produce legislation at the earliest opportunity. It is not reasonable to fail to address an issue and to leave some ambiguity within the law for three or four years, knowing that one can come back to it at a later date.
This measure is not the worst example because, to be fair, it talks about income received after 6 April 2008. My concern is that some transactions will have been entered into before that time. A transaction could have been entered into between the conclusion of the Legal and General case and 6 April on an understanding that that case had set the law. The interested parties would then find that the Government have come back and said that the law will be different and any income received as a consequence of the transaction will be treated differently.
This is a mere forerunner of our debate on clause 55. The amendment has successfully flushed out the issues. However, the Financial Secretary acknowledged that I recognised in my opening remarks that the amendment would create complexity and two parallel systems that would be far from ideal. Therefore, having put on record our concerns about how the Government have addressed the issue, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 54 ordered to stand part of the Bill.

Clause 55

UK residents and foreign partnerships

Colin Breed: I beg to move amendment No. 132, in clause 55, page 27, line 31, leave out subsection (4).

Jimmy Hood: With this it will be convenient to discuss the following amendments: No. 134, in clause 55, page 27, line 31, leave out ‘are treated as always having had effect’ and insert
‘shall have effect from 6th April 2008’.
No. 135, in clause 55, page 27, line 33, leave out subsections (5) and (6).

Colin Breed: I say at the outset that we accept entirely the need for the Government to legislate against tax avoidance. We appreciate that the provision is designed to prevent tax avoidance by United Kingdom taxpayers on income from foreign partnerships using Isle of Man or Channel Islands partnerships. It is based on an interpretation of the 1987 rule that was introduced following the Padmore case.
We support the Government’s efforts to deal with tax avoidance, but we still believe that, in principle, tax changes should apply prospectively and not retrospectively as set out under the measure. It has been the theme not only of some clauses this morning—it has been growing over the previous two Finance Bills, whereby the Government are making a determined effort to use retrospectivity as a tool for tax avoidance. While it was implemented in respect of a few things to begin with, it now seems to be creeping in in a new way. We are worried particularly by the effect of subsection (4), which will treat the new provisions as “always having had effect”.
As a result of the change, established tax law that has been on the statute book since 1970 has instantaneously been rewritten. Rewriting of legislation in such a way does not meet the legitimate expectation test. It sends out a damaging signal about the stability of the UK tax system, whereby business transactions made under one set of laws can then become subject to a different tax outcome at a later date due to the retrospective change in the rules. It is for that reason that the amendment would remove the measure.
Although we understand that the clause is directed primarily at transactions involving Isle of Man or Channel Islands partnerships, the European Union law principle of legitimate expectation needs to be respected. Taxpayers are entitled to understand the implications of a transaction that they enter into. Treating the provision as “always having had effect” runs contrary to Parliament’s intent over the past 30 years, which is to lay down rules whereby the tax effect of particular transactions can be changed or advance warning can be given of a change in the tax treatment in clearly identified circumstances.
In the late 1980s, an approach was adopted to counter a legal decision that had gone against the Revenue and which the Government wished to reverse. Although the new law was stated to “always having had effect”, it did not influence judicial decisions made before the new law was announced. A more recent approach was the statement made by the then Paymaster General to the effect that legislation would be introduced and be effective from 2 December 2004 in relation to what the Government consider to be unreasonable tax-avoidance schemes involving employment income.
Following that, in one of its report, the Treasury Committee said:
“The Inland Revenue should, without jeopardising their position, publish a paper setting out their thinking on the principles which will guide the way they implement”
the then Paymaster General’s announcement. Such a paper has never been published, but we believe that the philosophy underlying retrospective or retroactive legislation should now be examined in conjunction with the current move to introduce principle-based legislation. If the underlying purpose behind legislation or an area of tax law is articulated clearly, a taxpayer who respects that purpose should have certainty about the tax outcome of their particular transaction. If the underlying policy is to be changed, then any change should have effect only in relation to future transactions.
In summary, the application of the legitimate expectation test to this provision should be that any amendment applies only from the date that the change was announced—Budget day 2008. In respect of periods before that date, if HMRC believes that these interpretations are based on a wrong view of the law, they should be challenged through the courts. We believe an appropriate modus operandi should be agreed by the Treasury, HMRC and the representative bodies and then published for the benefit of all taxpayers.
My hope—and the other amendments in this group have a similar theme—is that the Government will live up to some of their promises, particularly in respect of the then Paymaster General’s announcement that we would get a paper of principles. It would enable us to understand this policy of retrospectivity, which commenced a few years ago and is almost going full steam ahead without that paper. The purpose of the amendment is to bring the matter to a head so that by the time we get to Report the paper that was announced a few years ago will have been published. We will then be able to judge the resultant clauses that the Government want to introduce in this Bill against that set of published principles.

David Gauke: Whereas on the previous clause we made our points in a probing manner, we do so here with much greater force. I associate myself with the remarks of the hon. Member for South-East Cornwall. The retrospective nature of the clause is deeply troubling. We fully share the Government’s concern about the issue that it is trying to address. There is a problem with the arrangements and it is perhaps more than just a kink in the system, as the Economic Secretary put it. Trading profits derived from UK land are being received tax free by UK residents and domiciled individuals because of schemes involving the establishment of offshore trusts, specifically in the Isle of Man.
The existing legislation appears to deal with the issue where the UK residents or domiciled individuals are partners in the relevant offshore funds, but it does not seem to work where the partners are trusts and the UK individuals are benefiting from the arrangement. There is not a problem with trying to address that point, but there is a point of principle here. The proposal essentially states that the amendments contained in the clause are to be treated as always having had effect. Either the law exists or it does not. It is troubling when the Government state that the law in the past is something because that is what they say it is now. That is essentially what subsection (4) states.
This is partly an issue of simple democracy. It raises issues about EU law and legitimate expectations. I shall not pursue that point, but the hon. Member for South-East Cornwall is right to raise it. In part, it cuts to the question of the certainty and stability of the UK tax system. For investors, the idea that UK tax law is likely to be changed retrospectively is unattractive, and the UK is, for various reasons, acquiring a reputation for having an uncertain and unstable tax system, which is bad for the UK economy.
This clause is but one example, but it has attracted considerable attention. Indeed, one leading tax expert described it as unprecedented. The Minister smiles, but I would be grateful if she gave some examples. She may seek to give the example of the 1987 case, but distinctions can be drawn with that. The 1987 provision, with regard to section 62 of the Finance Act 1987, seeks to reverse the Padmore case, to which we have referred. It says that the measure is deemed to have an effect except in relation to any judicial decision made before the amending legislation was announced. That is an important carve-out. It benefited not only Mr. Padmore, but a number of other individuals who had entered into arrangements and waited for the conclusion of the judicial proceedings relating to Mr. Padmore. In doing so, they benefited from that carve-out.
None the less, concerns were raised, and understandably so. I think that there was a certain amount of nervousness from the relevant Minister at the time—Norman Lamont, now Lord Lamont—but it may well be worth pointing out the comments made by the Labour spokesman about what was then clause 62. He said:
“Parliament should oppose retrospective legislation, for a number of reasons. The principal democratic reason is that people are perfectly entitled to do whatever the law permits them to do and that it is wrong afterwards to make it unlawful.”—[Official Report, 15 July 1987; Vol. 119, c. 1179.]
That spokesman—

Jane Kennedy: Who was it?

David Gauke: The Minister anticipates what I am about to say. That Labour spokesman was one Tony Blair. He did not always make the right comments, but on that issue he made a fair point. [Interruption.] I know that the words of Tony Blair do not hold much sway with those in the modern Labour party. That is a pity for them as well as the country.
There is the issue of timing, which we touched on in relation to the previous clause. I do not think that anyone would dispute that the provision is retrospective. It goes back at least to 1987, so that is 21 years. As I said earlier, there is the issue of HMRC and the Treasury not necessarily acting terribly quickly when becoming aware of the arrangements. The explanatory notes refer to the “new avoidance scheme”. This is not the first time in these proceedings that I have had to query the explanatory notes, but I am not sure that the expression “new avoidance scheme” is entirely justified. How long have the Government, whether through HMRC or the Treasury, been aware of the arrangements? There is certainly evidence that HMRC has been aware of the arrangements for some years. That raises the question that I asked earlier. It is incumbent on the Government to act reasonably quickly. If they become aware of a scheme that they do not like but they sit on their hands and do nothing about it, and then some years later say, “Okay, we will introduce retrospective legislation,” that raises real concerns, because again there is a continued period of uncertainty. I would press the Government to move quickly if they saw something wrong, rather than sit on it for a long time and then seek to introduce retrospective legislation.

Philip Hammond: I listened with great interest to my hon. Friend. He seems to imply that there is a concept of reasonable expectation. Where the Government are known to be aware of a practice and do not move to close it down, is it not the case that taxpayers have a reasonable expectation that the Government have chosen to tolerate that course of action, and plan accordingly?

David Gauke: My hon. Friend makes an important point. It comes back to legitimate expectation. If the Government do not act on something, perhaps they have taken the view that they will not pursue it. That argument has become stronger in recent years, as the Government now benefit from a disclosure regime. Schemes that result in people making tax savings are disclosed to HMRC, which has the opportunity to review the situation and introduce legislation. We have seen some examples of that in this and previous Bills.
It might be worth returning to the Rees rules, which we discussed on Tuesday. My hon. Friend the Member for Fareham discussed them with the Economic Secretary, and there was some disagreement over interpretation. However one looks as those rules, this provision does not comply with them. The rules set out three circumstances that apply with retrospective tax legislation. If anti-avoidance provisions are to be legislated, there should be a clear warning in the House of Commons, where feasible a draft law should be published as soon as possible—to give effect to the proposal—and the clause should be incorporated in the next available Finance Bill. I would be grateful if the Financial Secretary could enlighten us on the extent to which that process has been followed with these provisions. I am not sure that it has. The hon. Member for South-East Cornwall referred to the Padmore case and the previous Paymaster General’s warning about employment-related schemes going back to December 2004. When was the warning given and did legislation follow as soon as possible? The Government are not on particularly strong ground.
It is not acceptable that the Government permit something that they consider unacceptable to exist for some years, and then seek to introduce retrospective legislation to address it. That is what we see here. The comments from the professional bodies are universally critical. The Chartered Institute of Taxation described the retrospective nature as “extreme” and “unjustified”, the Law Society described it as “wrong in principle”, and the Institute of Chartered Accountants in England and Wales said that
“it sends out a very damaging signal about the stability of the UK tax system”.
In the light of that—I stress that we are talking about the retrospective element and not the intention of the clause—we are deeply concerned about the proposals. Hence, we have tabled amendments, which are in line with the intention of the hon. Member for South-East Cornwall in amendment No. 132. Looking at that, we have stated that the provision should have effect only from 6 April 2008. On reflection, we have been unduly harsh on the Government and it would be reasonable to say 12 March 2008, which was the date of the Budget as opposed to the beginning of the financial year, but given that the proposal has a retrospective effect of 21 years, I am not sure that one month here or there will make much difference. If the Minister wants to reassure us and say that she will introduce proposals to change the retrospective nature of the measure to date it back to 12 March 2008, I would happily withdraw the amendment and accept that as a fair compromise. I am being extremely reasonable—

Jane Kennedy: As always.

David Gauke: As always, as the Financial Secretary generously concedes. The proposal raises serious questions, however, about the way in which retrospective legislation is increasingly being used and we have deep concerns about that.

Mark Field: Unlike my hon. Friend the Member for South-West Hertfordshire, I am not merely troubled, I am very alarmed by the proposal, particularly when reading the words of subsection (4) that the hon. Member for South-East Cornwall rightly highlighted,
“are treated as always having had effect.”.
The argument about the retrospective effect of legislation is not merely an academic one, it reflects the potentially arbitrary and strong powers of HMRC. I suspect that later in our deliberations we will discuss precisely how those powers will operate, given the historical distinction between the powers of the Inland Revenue and those of Customs and Excise. It is of great concern that this particular wording is being used. I suspect that the Financial Secretary will tell us that this is a narrow case, but it sets something of a precedent. There are plentiful opportunities for the Government to examine anti-avoidance—we have a Finance Bill every year. All the time that I have been in Parliament, in Finance Bills year on year an inordinate amount of anti-avoidance provision has come into place, largely as a result of the fact that we have seen more complex arrangements being put in place. There are some broad philosophical issues about the arbitrary nature of the state’s power, but also some practical issues that other hon. Members have brought into play, about what this means for the stability of Britain as a place to do business, particularly for overseas investors.

Jane Kennedy: It is important to challenge the suggestion that this is an attempt to introduce retrospection as a thin end of what hon. Members might quite properly fear is a large wedge. That is not our intention. I understand that the 1987 legislation had retrospection that was unlimited and in effect went back to about 1945. This is a specific case where there has been serious abuse of the tax system.

Mark Field: As I understand it, the legislation 21 years ago made it absolutely clear that it was not in any way trying to unravel arrangements that had been put into place before the Padmore case of 1987, where as the wording of the subsection to which I referred, about the legislation being treated as always having had effect, should have alarm bells ringing in all of us as parliamentarians. We all know the tremendous power of the state and, in particular, the tax authority, and the detrimental effect that that is likely to have on external investment. I want to make the more general points only; I know that the specific points have been made from the Opposition Front Bench by my hon. Friend the Member for South-West Hertfordshire. I think that my hon. Friend the Member for Gosport also wishes to address the issue, but I hope that the Minister will give it serious thought. It is in the nature of having a Finance Bill every year that it allows the Government to make annual changes looking forward, but to have a retrospective effect with such stark words as those set out in subsection (4) should alarm us all.

Peter Viggers: There is a place for retrospective legislation. One of the better known cases was when someone intelligent discovered just after the second world war that the activities of the London fire brigade had been non-statutory and illegal. Parliament, in its wisdom, therefore decided to legitimise the London fire brigade, failing which matters such as compensation would have been extremely complicated. There is a case for retrospective legislation, but it should be reserved for those extreme, obvious cases. For the Revenue to use retrospective legislation to mop up bits of revenue law is simply unacceptable. If the Revenue is confident that the law has always been as it is now intended to be stated, surely it should challenge the case through the courts. The explanatory notes say:
“This clause will put it beyond doubt that the legislation has always had that effect.”
and the right way to challenge that is through the courts.
As I understand it, the Revenue has demonstrated that it was aware of the practice, and that the statement 
“the legislation has always had that effect”
is disingenuous. The Law Society has briefed me that paragraph 1660 of HMRC’s international tax handbook shows that HMRC had known for some time about the way that tax professionals have been interpreting section 858 of the Income Tax (Trading and Other Income) Act 2005. It also mentions that the original legislation to reverse the Padmore case, from which this tax planning arrangement derives, was controversial because it too was retrospective.
The way that HMRC operates provides for a tax-avoidance disclosure regime that allows the case to be put to Revenue and for clearance to be obtained. Given that the disclosure regime is available, there should be no need for any retrospective legislation. The current drafting of the Bill would give HMRC the right to turn a blind eye to a scheme and come back retrospectively and decide that it is illegal. That is an important point of principle, and I hope that the Financial Secretary will listen to those arguments.

Jane Kennedy: I am conscious that we may have a Division on this. It is a shame that the calming effect of the music from outside has not applied in the Committee room. Hon. Members have become agitated over something that, after giving my explanation, I hope that I will be able to—[Interruption.]—

Colin Breed: I do not know about a calming effect; I think that they were praying for the soul of the Government.

Jane Kennedy: TouchÃ(c). I was pleased to hear that the hon. Member for South-West Hertfordshire declared himself a Blairite, albeit a little late.
The Government understand some of the concerns about retrospectivity. It is right to be concerned about the use of that, and it is right for the Government to justify every case. The amendments would prevent clause 55 from being treated as always having had effect. That would take away a fundamental purpose of the clause, which is to put it beyond doubt that a wholly artificial avoidance scheme, which I will explain in a minute, does not work and never has done. As has been said, the avoidance scheme that the clause closes down was designed to frustrate legislation passed by Parliament in 1987 to prevent this type of avoidance, also with retrospective effect.
We have carefully considered what action should be taken against such artificial schemes, and we have not come to a decision lightly. In words similar to those used by the hon. Gentleman who spoke for the Opposition in 1987 and who I will come to in a minute, the now noble Lord Lamont of—

Mark Field: Lerwick.

Jane Kennedy: I am grateful, Lord Lamont of Lerwick.
I am satisfied that in these unusual circumstances, retrospective clarification of the law is fair, proportionate and in the public interest. That is the human rights test that we must apply.
It might be useful for me briefly to give some background. In 1979, Mr. Padmore, a UK resident, worked in the UK as a patent agent. He was also a member of a Jersey partnership, which had been set up to receive some of the income from Mr. Padmore’s activities as a patent agent. In line with the law as it was generally understood at the time, the Inland Revenue sought to tax him on his share of the foreign partnership’s profits. In December 1986, the courts upheld his claim that the tax treaty between Jersey and the UK meant that none of the Jersey partnership’s profits could be taxed in the UK, even those belonging to UK resident partners.
The decision was a surprise, not only to the Inland Revenue but to other tax authorities and most tax advisers. It overturned the generally held view that unless explicitly specified, tax treaties do not remove a country’s right to set taxes.

It being twenty-five minutes past Ten o’clock, the Chairmanadjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at One o’clock.